Theories for Legalizing Insider Trading I
There are two sides in every story and each side deserves ample print space to air their views. The same is true for the raging debate on insider trading. In previous articles I have tackled the views and theories on why insider trading should be prohibited and declared unlawful. It is only fair that the other side of the debate should be heard. For this article I will focus on the arguments that have been propounded by the advocates of legalizing insider trading. This group of scholars is said to represent the �law and economics� school of thought. There are two defenses that have been set up by these scholars to further their argument of legalizing insider trading.
The first defense that has been introduced by Manne directly answers the intention of the legislature to create a stable economy. Manne suggests that insider trading should be legalized because the trading made by insiders that are based on non-public information would be immediately reflected in the stock price of the corporation making the stock price a truer reflection of the corporation’s worth at a shorter period of time. You see the stock price is a representation of the true value of the corporation. Currently, this stock price is based on all information that is publicly available. If the insiders are allowed to trade, they would increase or decrease the value of the stocks based not only on publicly available information but even the confidential information making the stock price reflect the true value of the corporation at a faster time. Instead of merely relying on publicly available information, insider trading will create a truer reflection of the corporation. The stock prices would increase in its price efficiency thereby also increasing the capital market efficiency. But since corporations also rely on the stock prices to create major decisions, increased price efficiency would also create an increased level of economic output.
This first defense that was introduced by Manne illustrates how the stock market can benefit from legalized insider trading but it fails to show how legalizing insider trading would be beneficial to the other individual actors such as the investors, market professionals and liquidity traders. Fortunately for Manne, Carlton and Fischel were able to close this gap in his argument. According to them, the price efficiency that is brought about by legalized insider trading would benefit corporations as it reduces the investor’s uncertainty. A price efficient environment can also serve as a protection in keeping confidential information about the corporation.
The second defense of Manne states that insider trading can be beneficial to the interests of both the corporate insiders, meaning the corporate officers and employees and the non-insiders or investors. You see, if managers and corporate officers were allowed to trade it would be in their best interest to keep the corporation successful and profitable as they, themselves, would earn from the growth of the corporation. Insider trading would then make the corporate employees more motivated in doing a good job. A growing and profitable corporation with a dedicated work force will definitely favor investors and shareholders in the long run.